Fair Value Measurement in the Oil and
Gas Industry

The
lower item value condition over the most recent two years has introduced
challenges for regarding oil and gas reserves and unevaluated acreage gained by
E&P organizations. For money related announcing purposes, the essential
technique for regarding reserves is the income approach through the reduced
income strategy, while unevaluated acreage is ordinarily esteemed utilizing the
market approach by methods for the similar trade strategy.

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Exploration costs
are caused to find hydrocarbon assets. Evaluation costs are brought about to
survey the specialized plausibility and business suitability of the assets
found. Investigation, as characterized in IFRS 6 Exploration and Evaluation of
Mineral Resources, begins when the legitimate rights to investigate have been
gotten. Use brought about before getting the legitimate ideal to investigate
must be expensed.

Accounting
Standard Codification (ASC)-820 for Fair Value

The
standard of significant worth for money related detailing is fair value, which
is characterized under Accounting Standards Codification (ASC) 820, Fair Value
Measurements and Disclosures, as “the whole at which a assets or liabilities
could be obtained or sold in a present trade between enthusiastic gatherings,
that is, other than in a constrained or liquidation deal.”

E&E
assets are reclassified from Exploration and Evaluation when evaluation
procedures have been completed IFRS 6 para 17. E&E assets for which
commercially-viable reserves have been identified are reclassified to
development assets. E&E assets are tested for impairment immediately before
reclassification out of E&E IFRS 6 para 17. The impairment testing
requirements are described below. Once an E&E asset has been reclassified
from E&E, it is subject to the typical IFRS requirements. This includes
impairment testing at the CGU level and depreciation on a component premise.
The relief provided by IFRS applies just to the point of evaluation (IFRIC
Update November 2005). An E&E asset for which no commercially-viable
reserves have been identified ought to be written down to its fair value less
costs to sell. The E&E asset can never again be grouped with other creating
properties.

Valuation
Methodology

IFRS
6 introduces an alternative impairment-testing regime for E&E assets for
valuation of fare value of oil and gas. An entity assesses E&E assets for
impairment just when there are indicators that impairment exists. Indicators of
impairment include, yet are not limited to:

·        
Rights
to explore has expired or will expire in the near future without renewal

·        
No
further exploration is planned or budgeted

·        
Absence
of commercial reserves

·        
Sufficient
evidence available that clear that book value won’t be completely cleared in
future

Given
the idea of oil and gas operations, finding out a recoverable entirety may not
be immediate in light of the fact that a few resources may not yet produce
money in?ows, a nonappearance of information may exist about assets in a
particular zone, and/or the need to apply imperative appraisals and
suppositions identifying with segments, for instance, whole deal product costs,
trade rates, discount rates, future capital prerequisites, decommissioning
costs, investigation potential, reserves, and working execution and costs.

Oil
and gas substances measuring recoverable entirety using a fair value less costs
of sale figuring frequently don’t have an accessible cited cost for an
indistinguishable unit (gathering of units). Therefore, fair value less costs
of sale is frequently figured using other valuation procedures, for instance,
an income approach in light of a marked down money ?ow demonstrate.

Oil
and gas measuring for recoverable using fair value less costs of sell should
choose those valuation systems that are proper in the conditions and for which
adequate data is accessible to quantify fair value.

Valuation
techniques typically used to measure the fair value of oil and gas assets can
be grouped into three general approaches:

·        
Market
Approach (e.g., market information derived multiples)

·        
Income
Approach (e.g., present value techniques)

·        
Mixed
Approach (e.g., blend of market and income approach)

Disclosure
of the selected valuation technique(s) used to measure fair value less expenses
of disposal is required.

Key assumptions for Fair value Measurements

Companies
should evaluate the inputs and valuation techniques used in their reserve
reports to determine whether they meet the fair value measurement requirements
in ASC 820. Company-specific assumptions should be challenged to ensure that
they are consistent with the assumptions market participants would use in
developing a fair value measurement. Such an evaluation would include, however
isn’t limited to, whether:

·        
The
principal or most advantageous market has been appropriately considered.

·        
Appropriate
market participant characteristics have been identified.

·        
Adjustments
to the information are (1) based on observable or unobservable inputs or (2)
huge to the overall fair value measurement.

·        
All
valuation techniques that are appropriate in the circumstances and for which
sufficient information is available have been used.

These
considerations may result in a fair value measurement for the property that is
different from a company’s own reserve report.

An
oil and gas entity must disclose each key assumption on which management has
based its determination of fair value less expenses of disposal. Key
assumptions are those to which the asset’s (cash-generating units) recoverable
sum is most sensitive. If fair value less expenses of disposal is measured
utilizing a present value technique, disclosure of the markdown rate used is
required.

For
cash-generating units containing goodwill or intangible assets with indefinite
useful lives, if fair value less expenses of disposal is measured utilizing
discounted cash ?ow projections, notwithstanding the above disclosures, an oil
and gas entity ought to likewise disclose: the period over which management has
projected cash ?ows & the development rate used to extrapolate cash ?ow
projections.  To ensure that every single
relevant disclosure are provided, an oil and gas entity should review the
detailed disclosure requirements of IAS 36. The use of a disclosure checklist
might be a useful apparatus to support the review of disclosures.

Conclusion

Once the decision on commercial practicality
has been established, E assets are reclassified out of the E
category. They are tested for impairment under the IFRS 6 arrangement adopted
by the entity preceding reclassification. However, once assets have been
reclassified out of E the ordinary impairment testing guidelines of IAS
36 Impairment apply. Successful E will be reclassified to development.
Unsuccessful E must be written down to fair value less costs to sell,
because the shelter afforded by gathering these assets with creating assets in
a larger CGU shelter is not any more available.